Zen and the Art of Indemnification: An Inquiry Into Control, Fault and Liability by Jason R. Klinowski, Esq. A FREEBORN & PETERS FOOD INDUSTRY TEAM WHITE PAPER It is well known the great majority of indemnification clauses in produce supply agreements overwhelmingly favor the buyer, and most buyers will usually decline purchases unless an indemnification agreement is in place. KEY ELEMENTS Safety is of utmost concern in the food industry, but legal liability for recalls and foodborne illnesses may be changing: Sellers are no longer willing to accept full responsibility Control of the product is a critical element in balancing indemnification Various types of fault can be defined within an agreement Liability can be divided between the parties if an incident occurs To learn more about each key element, look for the key symbols throughout the article. On the surface, this makes sense because it is the seller who supplies the product the buyer s customers will consume. However, these provisions are almost always one-sided, overly broad, and seek to place any and all liability or other risk of loss onto the seller alone. Today s sellers no longer view one-sided indemnification as an acceptable business risk when food safety is factored into the equation. Instead, an ever-increasing number are willing to forego sales opportunities that make no attempt to balance the risks associated with the sale of produce. It is possible to find such an equilibrium, but only if both parties are willing to adopt a Zen-like philosophy of conducting business. Creating balance will be no easy task for sellers and buyers of fresh produce or the food industry as a whole. And if the many foodborne illness outbreaks in recent years weren t tragic enough, some of the largest companies in the industry have found themselves in court with savvy consumer groups fighting over allegations of misleading or incorrectly labeled products and ingredients. As recently reported by the New York Times (August 12, 2012): More than a dozen lawyers who took on the tobacco companies have filed 25 cases against industry players like ConAgra Foods, PepsiCo, Heinz, General Mills and Chobani that stock pantry shelves and refrigerators across America. The suits, filed over the last four months, assert that food makers are misleading consumers and violating federal regulations by wrongly labeling products and ingredients. While there has been a barrage of litigation against the industry in recent years, the tobacco lawyers are moving particularly aggressively.
Before a seller can warrant anything, the seller must know what it can and cannot control from both a practical and legal standpoint. With the entire food industry under attack, more and more sellers are rejecting single-sided indemnification provisions and demanding a more balanced indemnification agreement that reflects the realities of how these parties actually do business. This article proposes the structure of such an agreement and its value to both buyer and seller. INDEMNIFICATION AGREEMENTS: VARIATIONS A typical produce supply agreement with a major buyer, grocery retailer, foodservice company or restaurant will often contain a boilerplate indemnification agreement that reads something like this: Seller agrees to defend, indemnify and hold harmless Buyer from and against any claims, demands, liabilities, or expenses (including attorneys fees and costs) for any injury or damage, including but not limited to, any personal or bodily injury or property damage arising from, relating to, or connected with the use, possession, or resale of any and all Produce sold pursuant to this Agreement. In this example, the seller is obligated to bear all risk of loss or other liability associated with the produce sold to the buyer and the agreement does not allow the seller to avoid liability for acts or omissions that are outside its control. This can be remedied with a solid indemnification agreement that balances control, fault and liability. Although indemnity agreements are sometimes several pages long and cumbersome, concise wording that is singular in scope and addresses only the topic of indemnification between the parties can be created. CONTROL Control is the first critical element of an indemnification agreement that must be brought into balance. Some agreements require the seller to indemnify the buyer for any and all liability arising out of a breach of the seller s warranties as set forth in the agreement. Before a seller can warrant anything, the seller must know what it can and cannot control from both a practical and legal standpoint. With this understanding, the seller must be careful only to warrant things within its control. For example, a savvy seller will only warrant the safety of its produce as of the date of delivery, because after the seller delivers the product to the buyer, it is no longer within the seller s control. Control is also critical to the ability of the parties to properly define and balance the types of damages from which the parties seek indemnification. In a properly balanced indemnification agreement, the parties use control 2 A Freeborn & Peters Food Industry Team White Paper
Control is the first critical element of an indemnification agreement. Before a seller can warrant anything, it must know what it can and cannot do from both a practical and legal standpoint. to draw a clear distinction between product damages and distribution damages. Product damages are the damages and defects which are within the control of the seller and which exist on the date the seller delivers the produce to the buyer. Distribution damages are those damages and defects that arise after delivery of the produce to the buyer, usually as a result of another s negligence. Take the following as an example: a seller of produce delivers conforming goods to a buyer within the terms of the contract and the delivery is accepted by the buyer. Thereafter, the buyer neglects to store the produce properly, which results in consumers of the produce suffering from a foodborne illness. The injured consumers sue the buyer (who sold them the produce) and the buyer turns to the seller for indemnification. Under a single-sided indemnification agreement, the seller would be liable because its produce resulted in bodily injury related to, or connected with the use of [the] Produce. This would be the result despite the seller having performed all obligations of the supply agreement, delivered conforming goods that were not adulterated or defective on the date they were delivered, and the defect actually having been caused by the buyer. Under a buyer-seller balanced indemnification agreement, however, the buyer would be wholly liable for its negligence in storing the produce. Thus the buyer-seller balanced indemnification agreement draws an appropriate line between defects that arise while the produce is under the seller s control and those occurring while under the control of the buyer. Your Future Is Our Purpose www.freeborn.com 3
Balancing fault will remove significant liability from an indemnification agreement. This type of clarity, though awkward at first, may help strengthen relationships with members of the supply chain. FAULT The second critical element is fault. Both the seller and the buyer need to understand that fault must be properly balanced. To do this, the seller must utilize its understanding of control to provide the buyer with meaningful warranties and assurances without fear of nonperformance later. Such an understanding also allows the seller to define the types of fault that could reasonably occur during its control of the produce. To illustrate this point, please consider the following definitions: Seller s fault means: (a) a growing, harvesting or processing defect, packaging or labeling defect by Seller with respect to any or all of the Produce purchased by Buyer from Seller (collectively, the Seller Products ) that exist as of the date of delivery to Buyer or (b) Seller s gross negligence with respect to any or all of the Seller Products sold or delivered to Buyer directly or through an intermediary. Buyer s fault means Buyer s act(s) or failure(s) to act with respect to any or all of the Seller Products, including without limitation: (a) post-delivery handling, storage, movement, transfer, shipment, delivery, consumption or use any Produce sold or delivered to Buyer directly, or through its Intermediary, by Seller; (b) Buyer s removal, covering, alteration, complete or partial obliteration of or failure to provide one or more labels or other product information furnished or made available by Seller to Buyer with respect to any or all of Seller Products; (c) the gross negligence of either the Buyer or its intermediary, if any. Balancing fault will remove significant ambiguity from an indemnification agreement and spells out the type of actions or failures properly attributable to each party. This type of clarity, though awkward at first, may help strengthen relationships with members of the supply chain. Unlike one-sided agreements, a balanced indemnification agreement would require the buyer to assume financial responsibility for its post-delivery actions or inaction. That said, there is always the risk a latent defect (e.g., listeria) in the produce escapes detection until after consumption by the general public. In this type of situation, a balanced indemnification agreement would allow the seller to share liability with the grocery retailer or to assume full responsibility in the absence of any type of buyer s fault. Savvy counsel would make sure the respective faults fall within categories of activities covered by various insurance policies, force majeure clauses, etc. 4 A Freeborn & Peters Food Industry Team White Paper
One of the main purposes of a balanced indemnification agreement is to place the risk of loss in the hands of those who do not take the steps necessary to safeguard the public health. LIABILITY With control recognized and fault defined, we are now ready to balance the third critical element of an indemnification agreement: liability. This is important because civil complaints often allege both product and distribution damages, or they fail to discern the types of damages alleged. If this occurs, a buyer-seller balanced indemnification agreement will provide a mechanism for allocating the expense and risk of loss associated with unwanted litigation. In a balanced agreement, the parties should be able to allocate liability based on the proportion of product or distribution damages to the total damages awarded. For example, a seller of fresh produce could easily deliver conforming goods to a grocery retailer who subsequently fails to handle the produce in a clean environment, and further fails to store the produce at the appropriate temperature before selling it to the public. If a customer becomes ill as a result of consuming the produce, he/she could then sue both the grocery retailer and the seller. Under a single-sided indemnification agreement, the seller would carry all risk of loss simply because the produce was identified as the source of the problem and the seller was identified as supplying the contaminated produce. With a balanced indemnification agreement, the realities of who was in control and who was at fault would directly mitigate against any liability to the seller because of the buyer s actions or inactions. This is one of the main purposes of a balanced indemnification agreement, to place the risk of loss in the hands of those who do not take the steps necessary to safeguard the public health. Your Future Is Our Purpose www.freeborn.com 5
CONCLUSION While indemnification provisions in supply agreements have historically favored buyers, the current legal landscape of the food industry has demonstrated the need for a balanced in demnification agreement. Zen is obtained when the buyer and seller reach an agreement that both shares and allocates risk according to the realities and respective obligations of the parties. 6 A Freeborn & Peters Food Industry Team White Paper
ABOUT THE AUTHOR: Jason R. Klinowski Associate, Litigation Chicago Office Phone: (312) 360-6536 jklinowski@freeborn.com Mr. Klinowski is an Associate in the firm s Litigation Group and a member of the Freeborn Food Industry Team. His practice is concentrated on enforcing secured creditors rights in complex commercial litigation, including bankruptcy matters, USDA regulatory matters and general counseling, working primarily on matters arising under the Perishable Agricultural Commodities Act (PACA), the Packers & Stockyard Act, Capper-Volstead Act and numerous other agricultural statutes. Mr. Klinowski also represents financial institutions in connection with their agricultural lending practices and related litigation. Your Future Is Our Purpose www.freeborn.com 7
Freeborn & Peters offers clients the unique combination of business insight and legal acumen to address the complex challenges facing the food industry. The Freeborn & Peters Food Industry Team America s food industry faces many challenges: a rapidly modernizing food safety regime; a complex network of suppliers and buyers with many risks and potential liabilities; stagnant domestic demand and intense price competition. Our Food Industry Team helps food companies address these challenges. It also guides them as they build towards a better future: protecting investments in brands, innovation and facilities; structuring profitable ventures and M&A transactions; securing new financing; and taking advantage of foreign market opportunities. The Team s partners bring many years of experience, gained at multiple points in the industry and across different legal disciplines, including regulation, litigation, corporate law and government affairs. We combine legal know-how with business insight derived from careful attention to clients needs and an ongoing focus on the food industry s specific opportunities and challenges. CHICAGO 311 South Wacker Drive Suite 3000 Chicago, IL 60606 (312) 360-6000 (312) 360-6520 fax SPRINGFIELD 217 East Monroe Street Suite 202 Springfield, IL 62701 (217) 535-1060 (217) 535-1069 fax ABOUT FREEBORN & PETERS LLP Freeborn & Peters LLP is a full-service law firm headquartered in Chicago, with international capabilities. Freeborn is always looking ahead and seeking to find better ways to serve its clients. It takes a proactive approach to ensure its clients are more informed, prepared and able to achieve greater success not just now, but also in the future. While Freeborn serves clients across a broad range of sectors, it has also pioneered an interdisciplinary approach that serves the specific needs of targeted industries, including food, private equity and venture capital, transportation, and insurance and reinsurance. Freeborn is a firm that genuinely lives up to its core values of integrity, caring, effectiveness, teamwork and commitment, and embodies them through high standards of client service and responsive action. Its lawyers build close and lasting relationships with clients and are driven to help them achieve their legal and business objectives. Call us at (312) 360-6000 to discuss your specific needs. For more information visit: www.freeborn.com A version of this white paper appeared originally with the title Zen and the Art of Indemnification: An Inquiry into Control, Fault and Liability, Blueprints - The Produce Professionals Quarterly Journal in October 2012. Disclaimer: This publication is made available for educational purposes only, as well as to provide general information about the law, not specific legal advice. It does not establish an attorney/client relationship between you and Freeborn & Peters LLP, and should not be used as a substitute for competent legal advice from a licensed professional in your state. 2012-2014 Freeborn & Peters LLP. All rights reserved. Permission is granted to copy and forward all articles and text as long as proper attribution to Freeborn & Peters LLP is provided and this copyright statement is reproduced. 8 A Freeborn & Peters Food Industry Team White Paper